Can I Get a Loan From My Life Insurance?
Unlock the potential of your life insurance policy. Understand how to access its value, what it entails, and how to manage policy loans.
Policyholders can obtain a loan by leveraging the cash value accumulated within certain types of life insurance policies. This feature allows access to funds during their lifetime without traditional credit checks or a lengthy application process. These loans are an advance from the insurer, secured by the policy’s own value.
Understanding Cash Value Life Insurance
Cash value life insurance refers to permanent policies that include a savings or investment component in addition to a death benefit. These policies, such as whole life, universal life, variable universal life, and indexed universal life, build value over time. A portion of each premium payment contributes to this cash value, which grows on a tax-deferred basis, often earning interest or dividends. This accumulated cash value is distinct from the death benefit, which is paid to beneficiaries upon the policyholder’s passing.
The cash value provides a living benefit that policyholders can access. In contrast, term life insurance policies, which provide coverage for a specific period, do not accumulate cash value and therefore cannot be borrowed against. The growth rate of the cash value can vary depending on the policy type; for instance, whole life policies often have a guaranteed interest rate, while universal life policies may have more market-dependent growth.
How Life Insurance Loans Function
A life insurance policy loan is an advance from the insurance company, with the policy’s accumulated cash value serving as collateral. Policy owners are essentially accessing their own accumulated funds, up to a certain percentage of the cash value, often around 90%. Since the policy itself guarantees the loan, there is typically no credit check or extensive approval process involved.
Even with an outstanding loan, the policy’s cash value generally continues to grow and earn interest or dividends. Interest accrues on the loan balance, which is owed back to the insurer. The loan amount reduces the available cash surrender value and, if not repaid, will directly impact the death benefit.
Financial Implications of a Policy Loan
Interest accrues on the outstanding policy loan, and this rate can be either fixed or variable, depending on the policy’s terms. If the loan, including accrued interest, is not repaid before the policyholder’s death, the outstanding balance will be deducted from the death benefit paid to beneficiaries.
A financial risk arises if the loan balance, along with its compounding interest, grows to exceed the policy’s cash value. Should this occur, the policy can lapse, meaning the coverage terminates. A policy lapse with an outstanding loan can trigger adverse tax consequences. The Internal Revenue Service (IRS) may treat the unpaid loan amount as a taxable distribution, and the policyholder could owe ordinary income tax on any gains that accumulated within the policy exceeding the premiums paid.
Managing and Repaying Your Policy Loan
Policy loans offer flexibility as there are generally no strict repayment schedules or mandatory payments. However, interest continues to accrue on the loan balance, and if not paid, it will be added to the principal, increasing the amount owed. Policyholders have various repayment options, including making regular payments of principal and/or interest, or making lump-sum payments. Some choose to only pay the interest, allowing the principal to remain outstanding.
It is important to actively monitor the loan balance to ensure it does not grow to a point where it threatens the policy’s continued existence. Any outstanding loan will reduce the death benefit. To initiate a loan request, policyholders typically contact their insurance provider to confirm their eligible cash value and complete the necessary forms.